Extensive data shows that passive management has vastly outperformed its active counterpart net of fees for over a decade. This has helped induce a massive transfer of assets from active funds to exchange-traded funds (ETFs) and other passive alternatives and has sparked considerable debate about the future of active management and what role it should play in portfolios. investment How, for example, should sponsors of defined contribution (DC) plans approach the issue?
A recent CFA Institute Research Foundation monograph explored this issue, among many others of importance to DC plan sponsors. Media coverage of the book focused on the role of actively managed funds in the potential investment pipeline of a DC plan and prompted responses from some influential voices in the investment industry. Next, the authors of the monograph address the criticisms.
Our recent publication, Defined Contribution Plans: Challenges and Opportunities for Plan Sponsors, has generated considerable debate about a small segment of a very broad-based policy book. Some critics have misconstrued our discussion of the inclusion of actively managed investment options in defined contribution (DC) plan lineups. Much of this controversy was caused by an industry news article that incorrectly stated that we believed DC sponsors could be sued for hiring active managers.
We didn’t say anything about that.
Let’s be clear: we are skeptical of active management. Recruiting and retaining value-adding active managers is difficult, even when sponsors’ investment committees are guided by professional assistance. Some plan sponsors have considered the issue and have chosen to offer only a passively managed set of investment options. On the other hand, many sponsors have included actively managed investment options and have not suffered legal consequences for these decisions.
We do not believe that sponsors who conduct appropriate due diligence and choose to offer active investment strategies in their investment lines are exposing themselves to legal risks. We advocate that sponsors should do no harm in their selection of investment options. By this we mean that sponsors should carefully weigh the costs (fees, additional investment risks, participant communications and investment committee time) associated with active manager selection and, through their documented considerations, convince – it is known that the benefits exceed the costs. This would seem an obvious goal for choosing any investment option.
However, we want to emphasize that this statement is a policy guide, not a legal rule. What we proposed to sponsors is that they start with passive management as a basis for selecting investment options. Active management is based on deviations from a passive reference point. If active managers cannot add value, then passive is the preferred position, not the other way around.
This hardly seems controversial. We believe that many sponsors will and should reach this position. However, if a sponsor can satisfy itself through thorough research that the additional fees and additional risk of actively managing an actively managed strategy best serves the purposes of a segment of its plan participants, then the sponsor is justified in hire the manager. There is no serious legal risk involved.
Different sponsors will reach different conclusions about the value of active management in different asset classes and investment strategies. That’s why the active vs. passive debate has lasted 50 years and isn’t going away anytime soon.
We urge interested professionals to read our entire book. It is full of interesting observations and recommendations on the full range of responsibilities of DC plan sponsors. We expect readers to agree with us on some issues and (perhaps strongly) disagree on others. This is the nature of research and informed debate.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Jeffery V. Bailey, CFA
Kurt D. Winkelman
